These stocks have solid financials, robust business models and have a habit of surprising to the upside.
With the FTSE 350 index of Britain’s largest shares trading 20% off its highs recorded in February, it is clear that investors are still jittery on the continuing economic impact of Covid-19. While some areas of the market, like smaller-cap growth stocks, have fared reasonably well through the crisis, the index chart suggests a distinct sense of caution when it comes to large-caps.
But of course, index trends don’t tell the whole story. And when you look closer at the performance at a style level, there are clues that some stocks and certain sectors are recovering admirably from the pullback.
Source: Stockopedia. Past performance is not a guide to future performance.
Take, for example, an investment style that has worked very well in small and mid-cap shares in recent years: Quality & Momentum (Q+M), though shares that can be relatively expensively priced. High exposure to a combination of both quality and momentum is a strategy that tends to pick up the strongest shares in the market. They are the stocks with solid financials, robust business models that have a habit of surprising to the upside. The market loves them, but investors usually have to pay up to own them.
The hallmarks of a High Flyer, high Q+M strategy is that it’ll usually quickly direct you to profitable, popular names. In small-caps it will help you avoid ‘story stocks’ and value traps, while in larger shares it will keep you out of stocks that are unloved, underperforming and possibly in the wilderness.
But the risk of using momentum in any strategy is that it can reverse suddenly when the market gets spooked. Momentum in share prices or profits or forecast upgrades can all unravel quickly if sentiment changes. The quality element of this strategy helps to provide some insulation from that momentum risk, but it’s still an investing approach that needs careful watching.
Another advantage of looking through the Q+M lens is that it can be a pointer to those stocks and sectors that have broken away from general market trends. While the FTSE All-Share index might be 20% lower this year, a look at the performance of large-cap Q+M shares can offer ideas about where more positive action in the market can be found.
Here is a snapshot of UK large-caps with the highest overall exposure to quality and momentum right now. The Value Rank is an assessment of each share’s relative valuation - ranging from 0 (expensive) to 100 (cheap).
|Name||Mkt Cap £m||StockRank Style||Value Rank||Relative Price Strength 1y||ROCE %||Sector|
|Computacenter (LSE:CCC)||2,851||High Flyer||37||129.6||22.8||Technology|
|Ashtead (LSE:AHT)||13,001||High Flyer||41||61||12.2||Industrials|
|Spirax-Sarco Engineering (LSE:SPX)||8,413||High Flyer||13||76.7||15.7||Industrials|
|Rotork (LSE:ROR)||2,575||High Flyer||27||14.8||19.6||Industrials|
|Croda International (LSE:CRDA)||8,269||High Flyer||17||59.8||17||Basic Materials|
|AVEVA (LSE:AVV)||7,332||High Flyer||11||41.9||4.47||Technology|
|Bunzl (LSE:BNZL)||8,603||High Flyer||45||51.8||14.8||Industrials|
|Fresnillo (LSE:FRES)||9,782||High Flyer||14||146.9||7.09||Basic Materials|
|Hikma Pharmaceuticals (LSE:HIK)||6,177||High Flyer||36||56.3||20||Healthcare|
|Polymetal International (LSE:POLY)||8,141||High Flyer||42||76.4||28.8||Basic Materials|
It’s only a small sample, but the trend here is that high Q+M large-cap industrials - particularly those in engineering and manufacturing - have been leading the way recently. You can count among them names like Ashtead (LSE:AHT), Spirax-Sarco Engineering (LSE:SPX), Rotork (LSE:ROR), Croda (LSE:CRDA) and Bunzl (LSE:BNZL), together with UK tech-oriented shares like Computacenter (LSE:CCC) and AVEVA (LSE:AVV). The two precious metals mining shares, Fresnillo (LSE:FRES) and Polymetal International (LSE:POLY) are also a nod to the fact that higher quality miners have been increasingly popular this year as gold and silver have risen in price.
Quality and momentum as clue to outperformance
At the extreme, high quality and momentum can lead to relatively expensive valuations in shares. The idea with momentum is that these positive trends have a habit of persisting, meaning that the upward trend (and expensive price) can feasibly continue for considerable time.
The risk of course is that momentum can fade, and when it does the prices of these shares can fall sharply. So this is a strategy that needs careful attention. Paying a higher price for better quality shares on the move is a proven strategy of playing two very powerful drivers of returns in the stock market. In periods of uncertainty, it’s a strategy that may point you to positive trends that don’t show up on an index chart.
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